Bahrain Aid Programme To Restore Short-Term Stability

A new USD10.0bn aid agreement with Saudi Arabia, Kuwait and the UAE will support short-term economic stability in Bahrain and enable a return to international capital markets.

While the government's associated fiscal reform package will narrow the deficit, we maintain that social stability will take precedence over deep spending cuts.

We are sceptical about the stated goal of a balanced budget by 2022, and maintain our forecast of persistent, if narrowing, fiscal deficits over the next five years.

Bonds Regaining Value On Aid News

Bahrain - USD 12Y 2028 Yield-To-Maturity, %

Source: Bloomberg, Fitch Solutions

The signing of an aid package with Bahrain's Gulf backers will underpin near-term stability. Saudi Arabia, Kuwait and the UAE will provide USD10.0bn of aid in return for a new programme of fiscal restructuring, which was presented shortly after the aid deal was signed. The form that the aid will take - i.e. loans, grants, deposits or a mix - remains unknown at this stage. The aid initiative was initially announced in June 2018, in response to a sharp rise in Bahrain's sovereign bond yields. Investors had been concerned over the country's fiscal and external stability after the government cancelled a eurobond sale in March due to high funding costs. Bahrain's sovereign bond yields have steadily compressed as news on the final aid deal have trickled out over the past few days and weeks, and are now back at pre-sell-off levels ( see chart above). This implies that the government may once again be able to tap international bond markets if need be, allowing the Gulf funds to stretch a bit further. Our forecasts, which assume some fiscal consolidation, suggest that the aid money will roughly be enough to cover outstanding debt payments and fiscal deficits through 2020. Coupled with bond issuances, we could see it lasting until 2022 when the reform programme is set to finish.

Bahrain - Initiatives Under 2018-2022 Fiscal Balance Programme

Source: Ministry of Finance, Fitch Solutions

Initiative

Notable Reform Example(s)

Reducing government operational expenditure

Establishing six different taskforces to advise the Ministerial Committee for Financial Affairs and Rationalisation of Expenditure on specific ministerial expense requests. Areas include ICT, Travel & Transport and Gov't Building Rents

Voluntary retirement incentives for public employees

One-off direct cash compensation equal to five years of wages; end-of-service indemnity

Balancing Electricity & Water Authority's budget

Gradual adjustments to electricity and water tariffs

Streamlining distribution of cash subsidies

Redirecting cash subsidies towards eligible citizens

Improving efficiency of government expenditure

Establishing a central procurement unit to oversee the procurement process across ministries

While the associated reform programme is encouraging, we reiterate that social stability will take precedence over strict fiscal prudence. Prior to the announcement of the initiative, we argued that the government's efforts would concentrate on slashing capital expenditure (CapEx) and raising non-oil revenue, with few tangible moves towards cutting recurrent expenditure ( see 'Bahraini Government Spending To Tighten In 2019', September 19 2018). The announced programme largely conforms to this view, with the most notable deviation being adjustments to electricity and water tariffs. CapEx cuts are not mentioned, but will likely be a necessary part of the reform mix to bring down the fiscal deficit. As such, we have not made any notable adjustments to our fiscal deficit forecasts, which stand at 8.1% and 5.4% of GDP for 2018 and 2019, respectively.

Ultimately, we continue to believe that the authorities will prioritise social peace - a persistent worry in Bahrain, given tensions between the Shi'a-majority population and the Sunni government - over strict adherence to budget targets. Gulf backers are likely to condone this prioritisation, as maintaining the position of the fellow ruling Sunni al-Khalifa family is critical to denying Iran - the main regional rival to the UAE and to Saudi Arabia - another entry point of influence through Bahrain's large Shi'a population. The USD10.0bn also represents only a tiny proportion out of the Gulf backers' combined financial reserves, making the aid a low-cost, high-impact measure.

Rapid Gains Beyond 2019 Look Optimistic

Bahrain - Fiscal Balance Forecasts & Targets, % GDP

Source: Ministry of Finance, Fitch Solutions

The programme's ultimate target of a balanced budget by 2022 thus seems optimistic, in our view. We maintain our forecast for continued, if narrowing, fiscal deficits over the medium term, forecasting 4.0% in 2022. While the new reforms, coupled with rising oil revenue on the back of higher crude prices, will narrow the fiscal deficit, we do not expect the budget to balance by 2022. Achieving a balanced budget would, in our view, require more drastic spending measures, like freezes to public wages and hiring, coupled with further broad-based tax increases - all of which would be unpalatable to the restive population.